The g(u)ilty parties

There is much wailing and gnashing of teeth over the failed gilt auction. Commentators seem to be missing the important point.

The surprise is not that the auction failed but that it came so close to success. With £1.75 billion of gilts on offer, a hefty chunk even by today’s standards, offers to buy totted up to £1.67 billion.

It is, admittedly, rank bad news that the Government has failed to sell a batch of what is, after all, supposed to be the safest investment in the country. If the Government reneges on its debts then we are all up the creek.

However, suggestions that Bank of England Governor Mervyn King screwed it all up with ill-judged remarks is wide of the mark. The notion that King does not understand the gilts market beggars belief.

King said that the Bank would not spend the full £75 billion set aside for quantitative easing if the economic situation improved. Quite right. This money is not being put at risk for the sake of it and the less that has to be dished out into the economy the better.

Buyers of gilts are counting on the Bank of England’s money to prop up gilt prices, so the possibility that some will be withheld is disappointing from their point of view. However, that does not stop them from bidding for gilts at lower prices and in any case if the economy recovers then gilts will be more attractive anyway.

King has also said this week that the Government might have to scale back its spending plans and will be constrained from tax cuts. Such action would mean lower sales of gilts would be needed in future to plug the Budget deficit, which would make gilts more rather than less attractive.

Surely what scuppered the auction was that the gilts up for grabs were due to mature 40 years into the future. Who knows what will happen to interest rates between now and 2049 when we have so little idea of what will happen before 2009 is out?

Incidentally, it was amusing to see the Shadow Chancellor bemoaning the first failed gilts auction "for many years". He preferred not to mention that the last time it happened was in 1995, when we had a Conservative government.

Hopes deflated
The inflation figures are just awful. All this talk of the horrors of deflation has been so much hot air. It is inflation that is with us and it is not going away.

As I have commented before, one of the many drawbacks of reducing interest rates rapidly has been the effect on the pound, which has fallen sharply against the dollar and the euro.

Far from producing the much needed boost to exports, this has simply pushed up the cost of imported goods. Hence the poor inflation figures, which include higher prices of imported food, toys and fuel. Remember this the next time some supposed economic expert spouts on about the merits of a falling currency. A weak pound is bad news and a rapidly falling one is very bad news.

The Retail Price Index has dropped only because the cost of housing, both in terms of house prices and mortgage repayments, has sunk like a stone. Despite this distortion the figure has not, as expected, turned negative, though it has eased from 0.1% to 0%.

Already we have moans that this is the favoured index for wage settlements and so workers will get no pay rise this year. Try telling that to the people who do not have a job at all. When mortgages rose and the RPI was artificially inflated, wage rises were similarly higher. Those gains on the swings are now lost on the roundabout but the overall effect has evened out.

The Consumer Price Index, which despite its name is a more accurate reflection of retail prices because it excludes mortgages, has actually edged up from 3% to 3.2%, forcing Mervyn King to write an unexpected letter of explanation of why the figure is above the 3% target ceiling.

Oh dear. It’s perhaps as well that with interest rates at an all-time low of 0.5% they can hardly be reduced much further.

The stock market zoomed at the start of the week when the US produced its latest in a long line of plans to keep the economy going. As with the other measures already taken over there and over here, no-one knows if it will work or whether there will have to be yet another desperate measure.

In contrast, each item of bad news is all too tangible. It is encouraging that, despite everything, markets are still holding up remarkably well but we have failed to get back above 4,000 points on the Footsie and there is no reason to assume that we have seen the bottom yet.